In a Nutshell: Many risk assets broke higher last month as economic data continued to show weakness, but the overall outlook was better than expected. Bond markets are indicating interest rates may go higher from here.
Domestic Equity: Out of the Box
The U.S. stock market broke through the 3800-4200 range we’ve been highlighting all year. This breakout would lead to about a 4.5% return for the S&P500 for the month of June, finishing a strong first half for U.S. stocks despite a murky economic outlook.
Our participation chart shows we are back in positive territory, which is good. However, this participation gauge is still not over the February highs of this year. So overall, participation is neutral to positive.
Our sentiment indicator is up in positive territory, so this is a more healthy look for stocks than most of the year. Getting up near the red line indicates a strong move, but some cooling in the short term may be warranted.
Updated quarterly earnings results for the S&P 500 companies show what’s really been driving the market all year: The sentiment that markets are “not as bad as expected.” You can see the slight increase in earnings over the 2nd quarter. Although it was just a small 2% increase from the prior quarter, and down over 12% from a year prior, it was better than expected. This is really a microcosm of our economic activity as well, and perhaps the rationale for stocks going higher. That is, we are in a longer-term slowing path, but the short term has shown to be better than expected, thus hope exists.
As anticipated, the Federal Reserve did not raise interest rates in June – leaving their benchmark rate at the 5.00-5.25% range. This pause in the rate-hiking cycle may be short lived as the bond market is now pricing in, with high certainty, another rate increase at the end of July. Even more surprising is that yet another rate increase seems possible by year end. This represents a major shift in expectations from the start of the year. As long as the Fed’s preferred inflation measure PCE (not CPI) remains sticky, and the economy continues to be not as bad as expected, rates will likely increase.
Global Equity: A Failed Breakout
Global equities were up for the month of June, but could not hold the breakout that U.S. stocks enjoyed. Failed breakouts can be a cause for concern especially given the context for global stocks. The Eurozone is still struggling with sticky inflation and also posted back to back quarters of negative GDP growth, which means, technically, they are in a mild recession. Additionally, China’s economy continues to decelerate.
Despite a weak month of June for Japanese stocks, they are still firmly in an up trend. Japan has been one of the strongest stock markets across the globe and our economic forecasts suggest green grass ahead for the Japanese economy.
Real Estate: A Mini Breakout
June was a green month for real estate, with a small breakout through a small resistance price structure. This is certainly a start, but real estate has more work to do as the February highs are still a ways off. Additionally, real estate has been much weaker on a relative basis than stocks. All of the previously mentioned headwinds remain in play for this sector. Over the short term, price action has moved into positive territory.
Commodities: Continuing Lower
The commodities sector was green for the month, but still it remains under the important blue line from the chart below. That price position leaves the sector in negative territory. Inflation, while sticky still, has slowed with global demand. That leaves commodities in a tough spot and downward pressure on price.
Gold was down for the month, but still in a trend higher. Interest rates are running up again, putting pressure on gold. While gold is a great position to hold when the economy is in a slowing cycle, interest rates are ultimately the driver of gold prices. If interest rates keep driving higher, gold may lose its bullish trend.
Fixed Income: Interest Rates Remain Trapped
The 10-year U.S. treasury interest rate continues to ping pong back and forth within the blue box drawn below. The end of June saw interest rates pushing the 4% mark, near the top of the blue box. Inflation (PCE) continues to be sticky, and the economy is not slowing as much as anticipated, so the Fed’s message has been clear: Higher interest rates for longer. That clearly communicated mantra has been driving rates higher across the interest rate curve.
We are continuing to see record levels of yield curve inversion across the interest rate curve. When looking at the difference between the 2-year interest rate and the 10-year rate below we continue to push to levels not seen since the early 1980s. Historically, this is a very bad backdrop for the economy and eventually stocks. However, these periods of inversion can persist for 1-2 years prior to recession. We are in that 1-2 year window now, so this is a critical time for interest rates and the economy.
All Terrain Portfolio Update
Our model and indicators dictated that we add more risk to the All Terrain Portfolio model. This increase in risk was spread across domestic and foreign stocks and real estate. A good portion of our model remains in risk-averse, short-term treasuries that are paying interest in the 5.1% range. Economic data and outlook continues to be weak for the second half of 2023, so we will follow our indicators as we wait for investment opportunities, but remain agile and follow our process as new data is presented.
Past performance is not indicative of future results. Other asset classes or investment vehicles may be used in client portfolios and client portfolios may not hold all positions of the model at the same time as the model. This chart and its representations are only for use in correlation to the proprietary timing model by Arkenstone Financial, Registered Investment Advisor. Actual client and All Terrain Portfolio(TM) positions may differ from this representation.
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